Investments 

Beware the risks of virtual currencies

  • Learn about the history of Bitcoin and how ICOs work.
  • Comprehend how and why the virtual currency has grown and the hurdles it faces.
  • Understand the headwinds facing Bitcoin and the impact for wealth managers.
CPD
30min
Beware the risks of virtual currencies

Virtual currencies are becoming a more mainstream investment, but investors and their wealth advisers must be aware of the risks.

In the winter of 1928, Joe Kennedy made a quip that became famous around the world: “You know it's time to sell when shoeshine boys give you stock tips.”

This idiom articulates the risks that arise when a financial instrument becomes accessible to a mainstream audience who lack the sophistication to understand how to invest in it.

Whereas the shoeshine boy was providing an affluent and sophisticated investor with an equity tip, in today’s world, virtual currencies are following a similar path.

Not merely another vehicle for mainstream investors and speculators, virtual currencies have established themselves as a de facto asset class, one increasingly becoming part of a diversified wealth portfolio.

The rise of Bitcoin, the virtual currency

In the past two years, virtual currencies have become a phenomenon that has reached a mainstream audience. They have become so ubiquitous that terms such as “bitcoin” and “ether” have been accepted into the popular vernacular of ordinary people across the world.

The adoption rate is profound: Bitcoin was invented in 2008, languished as a niche currency with little adoption until 2013, and then exploded in value thereafter, up nearly 300 percent in the last two years.

Beware the ICO, Bitcoin’s wilder cousin

If Bitcoin took a long time to reach a popular audience, its cousin, the initial coin offering (ICO), has done so faster; since ICO came into existence in 2014, $1.2bn (£905m) has been invested in this asset class, with two thirds of that investment, $800m (£603m) having been made during August to September this year. 

An ICO is a form of raising money that is akin to crowdfunding, a share in the form of a virtual currency is created based on an underlying idea or business proposition that usually uses that virtual currency as its main method of transacting.

These currencies can be traded in and out of and exchanged into fiat currency, much in the same way as casino chips represent a lien on a casino exchangeable for real cash.

Blockchain companies have used ICOs to go on a fundraising tear, the peak of which being the recent raise by a company called Tezos (TEZ), a husband and wife team who raised $232m (£174.04m) in 42 hours through their ICO, which demonstrated a controversial notion of a self-amending blockchain.

Equally large raises have recently been completed by many other organisations, such as block.one, which raised $185m (£139.3m) at a more leisurely pace of five days, and Bancor, which raised $153m (£115.2m). Many of these raised the funds in an astonishingly short time: days, and in some cases, hours. The ICO market is currently growing at 800 per cent a year.

Comments

CPD
30min
  1. Bitcoin, invented in 2008, has risen how much in value in the past two years?

  2. Initial coin offerings, or ICOs, claim they are what in order to go around regulations designed to protect individuals and organisations against fraud?

  3. The Commodity Futures Trading Commission in the US recently declared Bitcoin what?

  4. Bitcoin's valuation has been driven up by a massive influx of capital from three countries in particular. Which is the odd one out?

  5. On 1 August this year, Bitcoin split into three currencies. True or false?

  6. As a mechanism for transacting, how many minutes does Bitcoin take to settle?

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